Adam Smith's Lost Legacy

Wednesday, December 31, 2008

A Physicist Finds the Invisible Hand Ain't There

“Dynamics of Markets or Perspectives on Positive Political Economy: econophysics and finance” by Joseph L McCauley, Cambridge University Press, 2007

“Standard texts and research in economics and finance ignore the absence of evidence from the analysis of real, unmassaged market data to support the notion of Adam Smith's stabilizing Invisible Hand. In stark contrast, this text introduces a new empirically-based model of financial market dynamics that explains the volatility of prices options correctly and clarifies the instability of financial markets. The emphasis is on understanding how real markets behave, not how they hypothetically 'should' behave.”

CommentProfessor McCauley is Professor of Physics at the University of Houston.

Modern economists like laud it over its sister social sciences because they regard our discipline as being akin to hard sciences like physics and not part of the sloppier ‘word’ sciences like sociology, psychology, anthropology, and such like (though there is in fact a great deal of quantitative work using hard data in these 'inferior' disciplines).

Well, hubris is well known to be an uncertain friend, especially when physicists begin to look over the advanced mathematical texts of modern economics and find them ‘primitive’ compared to where the hard sciences have moved on to since the 19th century (where economics is still stuck).

The first sentence ("Standard texts and research in economics and finance ignore the absence of evidence from the analysis of real, unmassaged market data to support the notion of Adam Smith's stabilizing Invisible Hand") summarises brilliantly the obvious problem, which Lost Legacy warns about daily:

‘how does the metaphor of an invisible hand actually work?’, or, more pointedly, ‘where is the invisible hand in the equations of, say, general equilibrium?’

Of course, there isn’t any such role for the invisible hand in their equations, not just because it cannot be modeled, but because it was always a literary metaphor and not a variable.

Smith treated the metaphor as such (he lectured in rhetoric too), as did most of his contemporaries and readers through to the late 19th century, when political economy slid into naked economics and finally into pure mathematics in mid-20th century.

From this, its exponents and popularisers found in the lonely metaphor a lovely magical allusion to something sacred and ‘nice’ to justify their version of the efficacy of markets.

The intention was perfectly worthy; markets were under the assault of the Soviet/Chinese ‘alternatives’ of full state control; of leftwing social democratic governments in Europe nationalizing the ‘commanding heights’ of the economy, with ambitions for state planning, and the Cold War was in earnest (Khrushchev, remember, threatened to ‘bury’ capitalism).

Any edge that economists could offer that favoured markets was welcomed by those not enamoured by the prospect of socialist state planning.

But, by grasping at ‘invisible hands’, falsely crediting them to Adam Smith, still a revered name in economics, and sliding over the absurdity of the notion, contradicted many times in Wealth Of Nations (over 50 times in Books I and II) – when markets were corrupted they were done so by humans, including by ‘merchants and manufacturers’, let alone capitalist-state interventions – they left the discipline open to ‘the Emperor is bare’ refrains when the hard sciences took a look at what such notions actually implied. Like Joseph L McCauley they findd them wanting.

Human behaviour does not comply with the hard sciences of physics, chemistry, atoms, electrons, orbits of planets or galaxies, gravity and space travel.

Smith warned about such illusions anout how human behave in Moral Sentiments when he talked of people not complying like wooden chess pieces, which are moved about the chess board by the hand that moves them. People have “a principle of movement of their own”. (TMS VI.ii.2.17: p 234; 1972 ed. Kessinger Rare Reprints, p 207)

Socialists and social democrats have never understood or accepted that basic flaw in their reasoning.

The real beauty of markets is not that there is an invisible hand – they don’t need one, and Smith never said they did – but that they work without the need for central direction; they need only the coordinating signals from relative prices, and while there are flaws and defects in them (after all, they are operated by humans) they are much better than all known and tried alternatives.

A Professor Forgets The Fallibility of Merchants and Manufacturers and That Ayn Rand was Not a Smithian

From comments published in Journalnow.com (Winston-salem) 31 December (HERE):

"Matter of degree"

"Jay Ambrose ("The end of talk about greed," Dec. 22) argues that criticism of greed during the current financial crisis is misdirected because economic self-interest is different from greed. Perhaps, but it is only a matter of degree.

Ambrose essentially restates Adam Smith's claim that an "invisible hand" harmonizes many self-interested actions to produce the public good. One way to state this is that motives don't matter much, because good results emerge anyway.

Unfortunately for Smith's modern disciples, motives do matter. Smith never revealed how real, fallible humans would keep too much of the "self" out of self-interest. And when the excess of self appears, Smith's magical "invisible hand" usually goes missing. Fraud, now making headlines, is only one of the results.

Allen Greenspan, former Federal Reserve chairman, and a disciple of the self-interest-takes-care-of-everything school, recently recanted. Said he, his faith in "the self-interest of lending institutions to protect shareholders' equity" had been replaced by "shocked disbelief" as the system collapsed. His awakening was too late. As Fed chairman, Greenspan's faith in self-interest led to his failure to regulate institutions that were engaged in blatantly risky behavior.

If Greenspan had regulated more, we might have avoided the disaster that is upon us. The public good is too important to leave to "invisible hands" that are invisible because they aren't there when it matters."

CommentProfessor Donald Frey is incorrect to assert that “Smith never revealed how real, fallible humans would keep too much of the "self" out of self-interest”.

It is a clear from Smith’s many references in Wealth Of Nations to the rapacious behaviour of ‘merchants and manufacturers’, when they are helped by legislators and those who influence them to ‘fix’ markets so that they can narrow the competition and increase prices through their monopolizing spirit, that he was well aware, and said so often enough, that ‘merchants and manufacturers’ often acted against the public interest whenever they could do so.

Allen Greenspan was a adherent to the philosophy of selfish egoism of Ayn Rand, which had little enough to do with the self interest and moral philosophy of Adam Smith.

I hope Professor Frey conveys the difference between Ayn Rand and Adam Smith to his students (and staff), and also understands that the modern notion of ‘the invisible hand’ bears no resemblance at all to Adam Smith’s sole use of the metaphor in Wealth Of Nations that had nothing to with markets.

Two Paragraphs, One Completely in Error, the Other Absolutely Right

Jeff Schweitzer, who served at the White House during the Clinton Administration as Assistant Director for International Affairs in the Office of Science and Technology Policy, writes “The Big Lie Exposed: Wall Street as Institutionalised Fraud” in the Huffington Post, HERE:

“Wall Street is everything that Adam Smith feared. Smith, the father of modern economics, said that the invisible hand only works in a society adhering to moral norms that prohibit theft and misrepresentation. Yet theft and misrepresentation are the twin gods of Wall Street.”

And

“The market looks nothing like that envisioned by Adam Smith. In stark contrast to Smith's theories, the Street's history is nothing but one of fraud for the simple reason that the entire enterprise is built on a deeply fraudulent idea: that the future can be predicted.”

CommentTwo paragraphs; one absolutely fictitious (the ‘invisible hand’ had to do with “society adhering to moral norms that prohibit theft and misrepresentation”) and one absolutely right (“a deeply fraudulent idea: that the future can be predicted).”

For the first paragraph, what more can Lost Legacy comment on the myth of the invisible hand? Read my posts in any week from this past year (or past years) and there is likely to be an explanation of the origins of this myth.

Briefly, one more summary: Smith discusses how markets work in society in Books I and II of Wealth Of Nations without mentioning the metaphor of ‘an invisible hand’. Not a lot of people, especially among economists and those they advise, seem to know this.

Smith used this popular 18th-century literary metaphor only once after explaining why some (not all!”) risk-averse owners of capital-stock preferred to keep their capital investments close to them rather than undertake the greater risks (and greater profits) of sending it abroad to the British colonies in North America, and how this resulted in local domestic investment in projects and consequent local employment being larger than it would otherwise be (the whole being the sum of its parts arithmetically).

Nothing was said about how markets work, and nothing about “society adhering to moral norms that prohibit theft and misrepresentation” associated with ‘an invisible hand’. Moral norms were central to Adam Smith’s thinking, but had nothing to do the metaphor of ‘an invisible hand’.

From anecdotal tales and oft-repeated media assertions, most people – among whom I think Jeff Schweitzer is probably included – appear to believe that Adam Smith’sWealth Of Nations is replete with ‘his’ so-called ‘theory’ of ‘the invisible hand’ of the ‘market’ and the ‘happiest of all possible happy societies’ (after Voltaire). It was a two word metaphor used only once in Wealth Of Nations; it was not a theory.

For further elucidation, may I suggest you download my paper, “Adam Smith and the invisible hand: from metaphor to myth" from the Home page of Lost Legacy (click the red words near the top of the page).

The second paragraph is true: the future cannot be predicted. Adam Smith did not make predictions about the future. And because the future cannot be predicted a great deal of modern economics is pure, though lucrative, mumbo-jumbo.

Banks, corporations, investment analysts, governments and their agencies, all hire high-salaried economists to predict the future; tv programmes and the media run regular features on the future of stocks, currencies and funds.

Like sporting outcomes, the unknown future creates the professional ‘science’ of probability, dressed up as prediction, otherwise known as gambling.

But this too had nothing to do with Adam Smith. When he mentioned ‘fortune’ it was clear that he considered it unpredictable.

Only in the models of neoclassical economics – absent as they are of people – do the players have perfect knowledge of each other’s preferences. On this paragraph, I agree with Jeff Schweitzer; as for the other paragraph we could not disagree more.

Tuesday, December 30, 2008

Adam Smith Accused of the Myth of the Invisible Hand

“But if we are going to get to the durable ideas that will show us the way forward, the way back towards life, then we are going to have to get around one product of "economic fantasy" whose shelf-life has been, and continues to be, particularly stubborn.

This is the myth that was planted in the modern mind by Adam Smith in the late 18th century. This is the myth-masquerading-as-market-making known as the Invisible Hand. Its shelf-life puts irradiation and ultra-pasteurization and EDTA to shame.”

CommentAh, but the fact is Adam Smith didn’t do any such thing. He used the metaphor of ‘an invisible hand’ once in Wealth Of Nations (Book IV), and his use of it had nothing to do with market-making, thoroughly covered in Books I and II, and without any mention of ‘invisible hands’.

Check it out for yourself.

The myth came from mid-20th century economists who invented a different use for the metaphor from that which Adam Smith used it (only once!) and their successors oversold it to the general public, who trust what prominent economics, including some Nobel prize winners, tell them.

See my paper, 'Adam Smith and the Invisible Hand: from metaphor to myth', downloadable from the Lost Legacy Home Page (in red ink near the top).

Adam Smith on Education

“Indeed, the controversy over public schools is as old as the tradition of public school itself. Adam Smith was the first to argue in favor of school vouchers, a cause taken up later by Milton Friedman, and many of Friedman's students and successors. It has now become a mainstay of the modern conservative movement, with little room for debate.

Smith and Friedman argued that the public school system should follow the rules of the free market, and that the best way to do this would be to put the public schools in direct competition with their private counterparts. Conservative theorists today argue that taxpayers who choose not to send their children to public school ought to receive a tax subsidy, or voucher, to help pay for the private school of their choice. The voucher would be paid to the school of the taxpayer's choice, rather than directly into the public school system. This creates a very immediate competitive dynamic between the public and private spheres, as the funding of one is entirely dependent upon the funding of the other.”

CommentLet me say, first of all, I agree broadly with the substance of E. D. Kain’s views on school vouchers as a means of improving the school system in the UK, which is failing broadly across the country, dominated as it is by a vast education bureaucracy, financed by taxpayers and managed by civil servants from the centre, operated through local education bodies and local schools, and ‘ran’ by state-paid employees (teachers and administrators) and their (several different) trade unions.

However, that is not my main interest in the above paragraphs.

“Adam Smith was the first to argue in favor of school vouchers.” I find this statement surprising and would respectfully ask where in Wealth Of Nations is this claim substantiated?

The situation which Adam Smith addressed is quite different from the educational circumstances of education provision in the developed countries today. Smith addressed another, more severe problem. It wasn’t that educational provision for children was deficient from what it could be, as now, but the fact that educational provision was almost completely absent for most children – girls, for a start, followed by most boys beyond a notional few years.

Smith knew that in Scotland, the situation was better than in England. He advocated in Book V, Article II, ‘Of the Expense of the Institution for the Education of Youth’ (WN V.i.f: pp 758-88; Canaan, ed. 1937. pp 716-40) the setting up – by government – of ‘little schools’ on the Scotch model, to which boys would be expected to attend to ‘read’, to ‘write’, and ‘account’ (p 785).

Moreover, he felt parents should contribute to a minimal education of their children via taxes and ‘moderate fees’:

“For a very small expence the public can facilitate, can encourage, and can even impose upon almost the whole body of the people the necessity of acquiring those most essential parts of education.”

And in these ‘little schools’ in every parish (there were about 60,000 parishes in England and Wales) “children may be taught for a reward so moderate that even a common labourer may afford it; the master being partly, but not wholly, paid by the public, because, if he was wholly, or even principally, paid by it, he would soon learn to neglect his business.”

The background was Smith’s (at least rhetorical) exposition of the dangers to society of failing to educate the majority of children who were destined for a life of drudgery and toil in mind-numbing employment (his famous and much misunderstood passage at page 782) against the consequences of the division of labour, much approved from a productivity point of view in Book I, Chapter 1 of Wealth Of Nations), but dangerous in Book V.

Thus, he warns readers that the ‘stupid and ignorant’ could become socially dangerous, “unless government takes some pains to prevent it” (which meant the richer minority should support public education instead of ignoring it).

Adam Smith was making a case for reform of the UK education system to deal with 18th century problems. It is somewhat disingenuous to apply it word-for-word to the 21st century, where educational vouchers would serve a completely different purpose by addressing the problems arising from the gigantic waste and expense of low quality publicly-funded provision for children from 5-18, and the lack of initiative and performance becuase they are dominated by militant trade unions and government bureaucrats.

Thomas Jefferson, quoted by E. D. Kain in his post, was familiar with Wealth Of Nations and was influenced by Adam Smith’s authoritative views on education from primary through to the (dreadful) state of the English universities (Smith excepted the four Scottish Universities from his assessments of the two English universities).

Jefferson favoured government attention to the ‘rudimentary education’ of the US population, clearly influenced by Smith’s account and the state of education provision in the new republic.

Osmosis From Fact to Fiction

“Adam Smith, whose 1776 work, The Wealth of Nations, is a foundational document of modern capitalism, taught that an "invisible hand" of self-interest guided the free market toward greater prosperity for all. In that famous volume, Smith wrote, "It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest." But self-interest, in Smith's view, is not the same as selfishness. Capitalism's prophet believed it's in everyone's economic self-interest to behave morally – which entails being trustworthy. As he and other enlightened defenders of the market argue, capitalism works only within a strong moral framework that creates social trust. Absent a common moral sense restraining our worst impulses, capitalism becomes a kind of piracy”.

CommentI would appreciate a source for the alleged quotation from Adam Smith’sWealth Of Nations.

Smith never used the word, ‘capitalism’, in anything he wrote. The word was not used in English until 1854 (by Thackeray in his novel, The Newcomes) and Smith died in 1790.

It is an example of metamorphosis by Chinese Whispers (message: ‘send reinforcement we are going to advance’ became, eventually, ‘send three-and fourpence we’re going to a dance’).

Of course, Smith did not teach ‘that an "invisible hand" of self-interest guided the free market toward greater prosperity for all’.

He certainly said that if the political economy of mercantile commerce, the state-run system of the 18th century in Britain, was replaced by repeal of the many laws of the then current prevailing orthodoxy, such as monopolies, protectionist tariffs, restrictive labour, settlement and apprenticeship laws, and laws of entail and primogeniture, colonial monopolies, wars to defend them from rival neighbours, and wars for trivial ends (the egoism of Princes and governments) and thyeir jealousies of trade, then there would be slow and gradual progress towards opulence across the whole population.

These had nothing to do with magical disembodied body parts or invisible hands. The process of the spread of opulence was known and knowable. His single use of the metaphor was about something else (risk avoidance) (see my paper: Adam Smith and the Invisible hand: from metaphor to myth', downloadable from the link (in red ink) on the Lost Legacy Home page).

Adam Smith On Specialisation

“Adam Smith’s Wealth of Nations [26] published in 1776 was one of the first works promoting “specialization labor” to improve productivity. He observed in pin making that the division of task into four separate operations increased output by a factor of almost five. Whereas one worker performing all the operations produced 1000 pins per day, ten workers employed on four more specialized tasks could produce 48,000 pins per day. The concept of designing a process to use the work force efficiently had arrived.

It should be noted, however, that what worked for one process (e.g., pin manufacture) in 1776 may not work well for a similar process today.”

CommentWealth Of Nations was not ‘among the first’ to promote the “specialization labor” to improve productivity. Adam Smith was a moral philosopher who did ‘nothing but observed everything’. He reported on what he observed. Many others before him had also noticed the division of labour, such as his tutor, Francis Hutcheson, not to mention Plato.

Entrepreneurs, or undertakers, did not need to read Wealth Of Nations to do what they were already doing and had been doing for centuries. If modern society depended on everybody reading one or two books, I suggest it would never have happened.

Smith understood this. Specialisation through the division of labour is not just a matter of splitting each main task in a small manufactory into many smaller tasks to increase output. It is also about splitting tasks (‘outsourcing’ today) into long supply chains, which Adam Smith illustrated with the supply chains involved in making the simple woollen coat of a common labourer – it’s in the much neglected second part of the ‘pin-making’ chapter [WN I.i.11: pp 22-24;Canaan ed. 1937: pp 11-12].

For these reasons (see my Adam Smith: a moral philosopher and his politcal economy, 2008, Palgrave Macmillan, for an account of Smith's - and Young's - significance in these matters), I do not agree that Smith's writing on specialisation and the division of labour "may not work well for a similar process today". If anything, Smith's description of the full supply processes work in ways not yet fully appreciated.

The full significance of his account of the manufacture of a woollen coat lay neglected until Allyn A. Young brought it to our attention in his 1928 article in the Economic Journal.

Eighty years later Young’s paper is still seeping into the consciousness of the discipline, particularly in attempts by neoclassical growth theorists to account for increasing (not decreasing) returns in their equations. The essence of the 'commercial' production process (long preceded by millennia of its slow and gradual social evolution) is fully revealed in parable of the 'woolen coat'.

Adam Smith Influenced Post-1783 US Land Law reform

David Brin, ‘scientist and bestselling author’, writes the Contrary Brin Blog, HERE: and on 29 December he posted:

“Truth & Reconciliation Addendum: How radical might it all get?”

“Time for a historical factoid. At around the time of the 1775 uprising that sparked the American Revolution, vast sections (up to half) of the colonies of Georgia, New York, Pennsylvania, and Maryland were owned by individual families under charters granted by the British crown. The great landlords were mostly royal cronies - personal friends of the king - who never even visited their vast new fiefs. (Such cronyism was cited by Adam Smith as the great destroyer of free markets, rather than socialism, which he considered a much less worrisme threat.)

How did that earlier generation of Founders solve the problem? Certainly seizure of some Tory assets had a great deal to do with the breakup of those grossly unfair, unearned estates -- and such things might happen again, if the People must rise up against a new feudalism. Still, mass confiscation is a bludgeon, at-best unreliable. Often, it only leads to a new class of meddling masters, even worse than those who came before.

Fortunately the main rebalancing technique that was used, just after the revolution was far gentler and less socialistic. Across the 1780s and 1790s, many states passed laws against “primogeniture"... the automatic inheritance of all real property and titles by the eldest son.

That was it. Simple. But it sufficed.

Recall that primogeniture had been a strong tradition, that let aristocratic wealth and power remain concentrated in a few families. Hence, for a generation, American society (through consensus political action) stepped in to severely limit a landowner's right to decide which of his children would receive what. Instead, for a while, the law demanded equal distribution among all offspring.”

CommentDavid Brin’s ‘factoid’, er, isn’t.

Adam Smith wrote about the political economy of colonies in Wealth Of Nations (WN IV.vii.b), which David Brin may wish to read to correct the false impression that it was the genius of the first generation of the Revolution to have discovered the means by which the newly independent colonies altered the economic history of the new states. It was certainly their political savvy which made the difference between the former British colonies and their South American counterparts, and became increasingly obvious within a few generations.

The Revolution’s leaders and many of their luminaries, right across the political structure of the new state, became familiar with Wealth Of Nations, for many years imported from Britain before an American edition was published (the Library of the US Congress holds George Washington's signed copy).

In Wealth Of Nations, many American readers no doubt turned to Chapter vii of Book IV: ‘Of Colonies’, and Part 2: ‘Causes of Prosperity of new Colonies’, where he discusses the failings of the Spanish, Portuguese, and French administrations (and has a disquisition of the early Greek colonies of antiquity), within which they would find the following:

“But there are no colonies of which the progress has been more rapid than that of the English in North America.

Plenty of good land, and liberty to manage their own affairs their own way, seem to be the two great causes of the prosperity of all new colonies.

In the plenty of good land the English colonies of North America, though no doubt very abundantly provided, are however inferior to those of the Spaniards and Portugueze, and not superior to some of those possessed by the French before the late war. But the political institutions of the English colonies have been more favourable to the improvement and cultivation of this land than those of any of the other three nations.

First, the engrossing of uncultivated land, though it has by no means been prevented altogether, has been more restrained in the English colonies than in any other. The colony law which imposes upon every proprietor the obligation of improving and cultivating, within a limited time, a certain proportion of his lands, and which in case of failure, declares those neglected lands grantable to any other person, though it has not, perhaps, been very strictly executed, has, however, had some effect.

Secondly, in Pennsylvania there is no right of primogeniture, and lands, like movables, are divided equally among all the children of the family. In three of the provinces of New England the oldest has only a double share, as in the Mosaical law. Though in those provinces, therefore, too great a quantity of land should sometimes be engrossed by a particular individual, it is likely, in the course of a generation or two, to be sufficiently divided again. In the other English colonies, indeed, the right of primogeniture takes place, as in the law of England. But in all the English colonies the tenure of the*39 lands, which are all held by free socage, facilitates alienation, and the grantee of any extensive tract of land generally finds it for his interest to alienate, as fast as he can, the greater part of it, reserving only a small quit-rent. In the Spanish and Portugueze colonies, what is called the right of Majorazzo takes place in the succession of all those great estates to which any title of honour is annexed. Such estates go all to one person, and are in effect entailed and unalienable. The French colonies, indeed, are subject to the custom of Paris, which, in the inheritance of land, is much more favourable to the younger children than the law of England. But in the French colonies, if any part of an estate, held by the noble tenure of chivalry and homage, is alienated, it is, for a limited time, subject to the right of redemption, either by the heir of the superior or by the heir of the family; and all the largest estates of the country are held by such noble tenures, which necessarily embarrass alienation. But in a new colony a great uncultivated estate is likely to be much more speedily divided by alienation than by succession. The plenty and cheapness of good land, it has already been observed, are the principal causes of the rapid prosperity of new colonies. The engrossing of land, in effect, destroys this plenty and cheapness. The engrossing of uncultivated land, besides, is the greatest obstruction to its improvement. But the labour that is employed in the improvement and cultivation of land affords the greatest and most valuable produce to the society. The produce of labour, in this case, pays not only its own wages, and the profit of the stock which employs it, but the rent of the land too upon which it is employed. The labour of the English colonists, therefore, being more employed in the improvement and cultivation of land, is likely to afford a greater and more valuable produce than that of any of the other three nations, which, by the engrossing of land, is more or less diverted towards other employments.” [WN IV.ii.16-19: pp 572-73]

Primogeniture was a regular target of Adam Smith’s in his writings and lectures. Britain was dominated by the ancient law of primogeniture and it was pernicious for all the reasons stated by David Brin.

However, typically, the law of primogeniture was made even more onerous by the legal device known as ‘entail’, which locked the entire estate into a non-divisible whole: no part could be inherited or sold separately; the whole estate could only be purchased subject to the entail applying in perpetuity.

The entail device was even more pernicious.

An inheritor, for example, finding himself (it was always male, of course) in need of funds to invest and improve his landed estate, assuming he was so inclined, or course, or he just wanted the money his prodigal life-style, could not dispose of parts of the estate; he had to sell, or pledge, the whole estate. This system prevented the development of a yeoman class of farmers on the one hand, and ensured the steady decline of landed estates inherited by persons uninterested in agricultural improvement.

No Revolutionary politician was unaware of the problems caused by primogeniture and entails. That some states had legislated before 1776 under British administration to reform primogeniture and entail laws was an excellent example to the rest post-independence. Adam Smith provided the political economy of the benefits of these moves.

I think David Brin, and others (many of them in the US media who seem to believe that history began only after 1783), should at least acknowledge that British thinking from the likes of Adam Smith, played a not insignificant role in the deliberations of the post-Revolution leaders and those who influenced them.

David also seems in his post (follow the link) to think that Adam Smith was aware of ‘socialism’ as an alternative to private ownership. He wasn’t. That was an issue in the 19th century, not the 18th.

The alternative to the commercial societies of the 18th century, guided by mercantile political economy and that it entailed, was Adam Smith’s version of commercial society, as outlined in Wealth Of Nations, absent monopolies, protectionism, jealousies of trade, special interests and their client legislators and those who influenced them, colonies, and wars for the trivial ends of princes and their governments. Smith had no views of ‘socialism’; it was not agenda in his day.

Whether he would have been a member of the Democratic Party is pure conjecture – about as relevant as whether he would have supported the New York Giants, or Manchester United…

Another Fairy Tale

”Marketolatry has been the reigning religion of global capitalism. It has exhibited blind faith in Adam Smith’s “Invisible Hand” (I. H.), which Smith believed governs the allocation of resources, capital and labor in the most efficient possible way.”

While Smith’s confidence in the market to self-regulate was conditional, later apostles like Milton Friedman and Alan Greenspan turned that principle into dogma. And dogmas have a way of becoming unconditional.”

CommentPeople ascribe views to others also ‘need honesty”, which in this case requires acknowledgement that Adam Smith said no such thing. He did not ‘believe’ that that an invisible hand “governs the allocation of resources, capital and labor in the most efficient possible way.”

That is pure hyperbole and is untrue in every respect.

It may be that Friedman and Greenspan believed such nonsense, but Adam Smith did not. That a correspondent to a newspaper believes it to be true is a measure of how deep the myth of the inviisble hand has penetrated a nation's consciousness.

Monday, December 29, 2008

Something For the New Year?

‘According to Fred Barnes, Obama has some "unusual ideas about the economy":’

"The American economy has worked in large part," he said last week, "because we've guided the market's invisible hand with a higher principle: that America prospers when all Americans can prosper." ‘That's not exactly the way Adam Smith described the invisible hand of free markets.’

CommentThe fact is Adam Smith never described anything about how ‘free markets’ were led by ‘an invisible hand’.

That is a myth, only sustainable by not reading Wealth Of Nations and, instead’ relying on statements about it by other who have not read Wealth Of Nations too.

If they did read Wealth Of Nations they would read through Books I and II, where Adam Smith describes and explains in detail how markets work without once mentioning the metaphor of ‘an invisible hand’.

They would also read Book III on ‘progress towards opulence’, which doesn’t mention the ‘invisible hand once’. The same with Book V, on government expenditure an taxation.

This leaves Book IV on mercantile political economy and the French Physiocrats, which does mention ‘an invisible hand’ for the first and only time in Wealth Of Nations, but this was not about markets and the invisible hand.

Strange, given the prominence associated with the myth that Adam Smith applied the fairly common literary metaphor to his theory of markets, and given the absolute confidence with which this myth is perpetuated by academe, including Nobel prize winners (who should know better), tutors across university campuses, graduates, and media commentators.

You can read my paper, “Adam Smith and the invisible hand: from metaphor to myth”, by returning the Lost Legacy Home page, and clicking on the link (in red 'ink'; you can't miss it).

Sunday, December 28, 2008

Adam Smith Did NOT Have a Labour Theory of Value Outside Hunting

"The Marxists were right --- sort of. Actually it would be remarkable if they were consistently wrong. But Marxism is not consistently wrong. But, often when it is wrong, it is wrong in astoundingly gigantic ways. The clearest example of that is Marx’s labor theory of value. I don’t blame Marx too much for that error, after all he borrowed it from Adam Smith and David Ricardo”

CommentI am not sure exactly what ‘CLS’ is getting at but I am sure that he does not understand Adam Smith on the so-called labour theory of value (LTV).

First, ‘CLS’ is wrong to name Adam Smith as the originator of what became known as LTV. It was a fairly common view among philosophers before Smith presented his framework (John Locke was prominent exponent long before Adam Smith). And Marx in the so-called fourth volume of Capital, ‘Theories of Surplus Value’ in which he lists all the earlier authors (including Adam Smith) from the 16th century onwards who influenced him in the 19th century (in his view) by getting their LTV wrong.

I have argued for some years now (I even have a draft paper, to which I intend to return) that Adam Smith did not have a LTV at all, except for the hunter/ scavenger – gatherer, first age of mankind.

It is quite clear that when the hunter or gatherer goes out into the bush to collect food for sustenance, animal skins for warmth, and wood to make shelter, that as it is his (or her) own labour that provides these resources, that these items belong to the labourer; he is the sole source of labour and therefore the sole owner of what he labours to produce. In that principle, in conformity with what Adam Smith understood as Natural Law (from Samuel von Pufendorf, the Natural Law jurist, he was perfectly consistent and right.

Smith makes it clear in Wealth Of Nations (I shall add references later as I am about to leave for a seasonal house party at my daughter’s) that with the appearance of property (shepherding, agriculture, and commerce), the labourer of the forest was no long the sole source of products desired by humans; it was not just his labour alone that made it possible to provide sustenance, clothing, and shelter (later the ‘annual output of the necessities, conveniences, and amusements of life).

The land was no long ‘free’; somebody else ‘owned’ it and charged for its use or exploitation; the means of subsistence (capital stock or the ‘grub stake’ until products were available) were contributed by others, who made what they owned available for use by the labourers. These other owners required a share in the output produced by whomsoever sought access or use of what they owned. The labourer’s labour was not longer the sole input; it was one of several inputs owned by others.

At this point the LTV dropped out of Adam Smith’s reckoning. He says so several times. But because this part of Wealth Of Nations is ‘badly’ explained and muddled it is not clear to fast readers, or readers of isolated quotations, or third-hand, off the cuff, remarks by tutors, media commentators, or the politically inclined, the myth has grown up that Adam Smith had a LTV for commercial (and by extension, capitalist) economies had a LTV and KarlMarx developed into his theory of surplus value.

Marx’s theory is quite different. The ‘surplus’ is the contribution of the other owners of inputs. He simply appropriates it from the other contributors!

A Smithian Scholar Moves to Take Charge

"Michael Ignatieff drags around the longest paper trail of any Canadian politician. As an author, professor, high-brow journalist and broadcaster, he wrote a stack of books, countless lectures, and many articles, not to mention documentary scripts, usually about human rights, foreign affairs, and security. But not much about the economy. And as federal Liberal leader—the job he landed sooner than expected at the end of the recent parliamentary crisis—economic policy is his first priority.

Ignatieff’s two-pronged prescription—stimulus based equally on compassion and competitiveness—might sound suspiciously like a politician trying to be all things to all people. But his interest in blending ideas about creating and spreading wealth go back to his early days as an academic.

In 1983, when he was a research fellow at Cambridge University, Ignatieff collaborated with economic historian Istvan Hont on a paper about the 18th-century Scottish philosopher, and icon of economic conservatism Adam Smith. They read Smith’s Wealth of Nations as more than the foundational work on how competition creates prosperity. “Our argument,” Ignatieff and Hont wrote in the introduction to an essay collection entitled Wealth and Virtue: The Shaping of Political Economy in the Scottish Enlightenment, “is that the Wealth of Nations was centrally concerned with the issue of justice, with finding a market mechanism capable of reconciling inequality of property with adequate provision for the excluded.”

Ignatieff studied Smith at about the same time Harper was taking economics at the University of Calgary. Whether in England or Alberta, the academic atmosphere of the early 1980s was charged with the conservative doctrines of Ronald Reagan and Margaret Thatcher. For Harper, that climate was formative, pushing him permanently to the right. Ignatieff remained a Liberal, but the era’s lessons weren’t lost on him. “If you’ve studied and written about Adam Smith, you’re a believer in markets,” he said. “But Smith always believed that markets had to be regulated. So I’m a market guy, and I think we’ve all discovered that light-handed, smart regulation by government is needed to keep markets safe, honest, fair and transparent—that’s the lesson of the past six months.”

CommentMichael Ignatieff has a distinguished academic record among Smithian scholars. He co-authored chapter 6, “Needs and justice in the Wealth of Nations; an introductory essay” (pp 339-443), in Istvan Hont’s magisterial, Jealousy of Trade: internatiomnal competition and nation-state in historical perspective, 2005, Belknap Press, Harvard, which alone establishes the quality of his credentials.

That he now has a career in Canadian politics as the federal leader of the Liberal Party provides a unique setting for him to switch from an observer into a doer and from being an influencer to a legislator.

I shall watch his progress as an opposition leader towards government with close interest.

Saturday, December 27, 2008

A Text for the Season

Nick Nejad, in Rational Angle, selects a short extract (HERE) from Adam Smith’s“Theory of Moral Sentiments”

“...As nature teaches the spectators to assume the circumstances of the person principally concerned, so she teaches this last in some measure to assume those of the spectators. As they are continually placing themselves in his situation, and thence conceiving emotions similar to what he feels; so he is as constantly placing himself in theirs, and thence conceiving some degree of that coolness about his own fortune, with which he is sensible that they will view it. As they are constantly considering what they themselves would feel, if they actually were the sufferers, so he is constantly led to imagine in what manner he would be affected if he was only one of the spectators of his own situation. As their sympathy makes them look at it in some measure with his eyes, so his sympathy makes him look at it, in some measure, with theirs, especially when in their presence, and acting under their observation: and, as the reflected passion which he thus conceives is much weaker than the original one, it necessarily abates the violence of what he felt before he came into their presence, before he began to recollect in what manner they would be affected by it, and to view his situation in this candid and impartial light.

The mind, therefore, is rarely so disturbed, but that the company of a friend will restore it to some degree of tranquillity and sedateness. The breast is, in some measure, calmed and composed the moment we come into his presence. We are immediately put in mind of the light in which he will view our situation, and we begin to view it ourselves in the same light; for the effect of sympathy is instantaneous. We expect less sympathy from a common acquaintance than from a friend; we cannot open to the former all those little circumstances which we can unfold to the latter; we assume, therefore, more tranquillity before him, and endeavour to fix our thoughts upon those general outlines of our situation which he is willing to consider. We expect still less sympathy from an assembly of strangers, and we assume, therefore, still more tranquillity before them, and always endeavour to bring down our passion to that pitch, which the particular company we are in may be expected to go along with. Nor is this only an assumed appearance; for if we are at all masters of ourselves, the presence of a mere acquaintance will really compose us, still more than that of a friend; and that of an assembly of strangers, still more than that of an acquaintance.

Society and conversation, therefore, are the most powerful remedies for restoring the mind to its tranquillity, if, at any time, it has unfortunately lost it; as well as the best preservatives of that equal and happy temper, which is so necessary to self-satisfaction and enjoyment. Men of retirement and speculation, who are apt to sit brooding at home over either grief or resentment, though they may often have more humanity, more generosity, and a nicer sense of honour, yet seldom possess that equality of temper which is so common among men of the world.”

[TMS I.i.4.8-10: pp 22-23; 1872, Kessinger Rare Reprints, pp 22-23]

CommentThis is an important extract from Moral Sentiments, particularly the last paragraph about ‘society and conversation’. The society of other people and the normal relations of conversation with them is a harmonising influence of great consequence – yes, I know that conversations can cause trouble too – but the resolution of troubles requires conversation, as Smith notes:

“Men of retirement and speculation, who are apt to sit brooding at home over either grief or resentment, though they may often have more humanity, more generosity, and a nicer sense of honour, yet seldom possess that equality of temper which is so common among men of the world.” [Emphasis added]

Robert Burns, captured lonely brooding brilliantly when he wrote of the wife waiting at home in anticipation of her drunken husband's late return, in Tam O'Shanter: 'nursing her wrath to keep it warm'.Burns read and admired Moral Sentiments and traces of his reading can be found in some of his poems.

Lost Legacy Posts Rate Increasing, and Readers too

Lost Legacy began in February 2005 and it reached its first thousand posts in July 2007, 29 months later.

Currently it has added another 704 posts from July 2007 to December 2008, 17 months later, standing tonight at 1704 altogether.

All very encouraging.

Looking at the monthly ‘unique visitors’ these stood at 4,675 for January 2006 (or first year) and the number of ‘page-views’ was 18,898 (suggesting that unique visitors were reading roughly 4 pages a visit).

For January 2007, the comparable figures were 12,550 ‘unique visitors’ and 53,585‘page views’, a nice increase.

For December 2008 (December 1 to December 26, with a few days to go and during a ‘holiday’ month) the nearly comparable figures were 15,685 ‘unique visitors’ and 92,427 ‘page views’.

These too are encouraging.

Lost Legacy is coming up towards 200,000 unique visitors and a million ‘page views’ a year.

I notice that the rate of readers’ comments on my posts is increasing, albeit ‘slowly and gradually’ too. For these comments, I am much grateful because it is from readers’ comments, positive or negative, that I get feedback about what you the reader wants me to cover.

Weeks or months without comments at all, is not quite discouraging, but it gets lonely wondering if I am talking to myself!

Thank you all who take the trouble to read Lost Legacy posts – and to those other economics Blogs that refer to Lost legacy or reproduce extracts, or whole posts even; it is the best form of reward to be noticed without getting big headed (to paraphrase Adam Smith in Moral Sentiments).

A Debate 'Rages' on Modern Economics

Readers are recommended to follow the link and see whether you agree with Richard Murphy that economics is not a science or with his protagonist, Tim Worstall, that Richard is striking at straw men and missing the point (that his caricature of modern economics is empty of relevant content). Richard keeps claiming that he has ‘won’ and that Tim has ‘lost’, though Tim keeps coming back with credible arguments in support of his propositions and in opposition to Richard’s. At which point Richard unilaterally called the debate off.

Now, I have an interest in this ‘debate’, as regular readers would note, in that I am concerned at the obsession of modern economics of understanding their models rather than the real economy. I am not too fond of notions of general equilibrium either. But modern economics has developed some useful tools to aid policy making, a point tellingly made by Tim, and studiously avoided by Richard.

There is an extensive comments section between Richard and Tim, which must be read as it elaborates many of the themes raised in the debate, most of them revealing what is at stake.

Richard seems to be firmly convinced by the Green arguments about man-made climate catastrophe and the prediction that the world is collapsing from over-consumption by the richer economies (which leaves the poorer economies future somewhat bleak). Richard doesn’t say anything about what he would do about that appalling problem, other than it’s all the fault of ‘neo-liberals’, a shadowy group which everybody can believe in if it is repeated often enough (replacing the Jews as the scapegoats of the last big depression in the 1930s?).

What was an intelligent debate seems to have slid into wild accusations towards the end; it all going one way in fact.

As a Smithian economist, I take the view that human kind is unlikely to decide about these matters by some sort of scientific agreement. Plans to ‘save’ the world will give the would-be planners comfort, but not much else, and is already this decade’s political title, self-awarded by the Prime Minister, and probably mumbled by Al Gore too.

Of course, ‘activism’ (like sitting on runways, blocking traffic, digging up GM crops, or worse) will happen. But if the ‘remedies’ of the activists are inappropriate, they may well be worse than adjusting to the discomforts of climate change (a less directional prediction to the former title of ‘global warming; it takes in a new ice-age too, and one of them of bound to be right, eventually).

Disclosure: I too am a Fellow of the Adam Smith Institute, but I do not follow a strictly ‘neo-liberal’ agenda, at least as presented by Richard. I favour competitive markets where possible and state intervention where necessary, as Adam Smith did.

In view of Richard's limited view of exchange relations, I recommend that he downloads my paper, "The Prehistory of Bargaining: a multi-disciplinary treatment", from the Home Page of Lost Legacy (in red near the top).

Adam Smith on Competition Among Religous Sects

Catherine Rampell writes in the New York Times, 26 December, on “Hanukkah Economics” HERE:

“What Would Adam Smith Say About Today’s Hanukkah?

A Slate piece, by the Columbia Business School professor Ray Fisman, talks about Adam Smith’s argument for why religious competition was a good thing, and whether it stands up to the fact that “a minor holiday largely unrelated to Judaism’s core values has earned outsize importance, primarily so parents can bribe their kids into keeping the faith.”

CommentHanukkah is a Jewish religious festival, which “commemorates the rededication of the Holy Temple in Jerusalem”, on the ‘25th day of Kislev’ and is celebrated for eight days in November or December. It pre-dates the Christian ‘Christmas' by 200 years, though the coincidence of dates may be fortuitous.

However, Ray Fisman, may (I have not read his article) be misreading Adam Smith on religious competition. This had little to do with economic competition; it related to the power of an Established Church.

In England the Church of England was (and remains) the official church, headed by the sovereign (who, by law, still enforced, cannot marry a Roman Catholic; I take it marrying a Jew or a Moslem is out of the question).

In Scotland it was, and is, the Church of Scotland, detached from government and in many senses superior to the weak governments at the time. Scotland ‘lost’ its parliament when the two countries formed a parliament of the United Kingdom – the crowns had unified a century earlier when James VI of Scotland became James I of the United Kingdom (North American friends and antipodeans, please note that there is no such title extant as the ‘Queen of England’).

Smith’s concern was with ecclesiastical establishments that were aligned with political interests. In becoming Established, such churches became embroiled in ‘violent religious controversy’ and ‘violent faction’ (Wealth Of Nations, V.i.g: pp 788-814; Canaan, 1937. pp 740-66) Before my Islamic friends smirk at the Christian capacity for ‘violent controversy’ over holy doctrines, please contemplate the murderous contentions between today’s Sunni and Shia adherents.

Zeal and religious enthusiasm go together, and Adam Smith and others had personal, almost daily, experience of zealot-led disturbances in Scottish life in the 18th century, especially on Sundays when named individuals were treated abominably for whatever ‘sins’, real and imaginary, had come to the attention of zealot-minded busy bodies.

The last person hanged for blasphemy was a student, Thomas Aikenead, on 8 January 1697; the last witch burned to death was Janet Horne in 1727 (when Smith was just 4 years old); ‘the never to be forgotten’ Francis Hutcheson, a minister of the Ulster Church, experienced the ire of ignorant zealots in a petty incident when they accused him of apostasy (Smith was his student at Glasgow University, 1737-40).

Smith favoured that ‘every man [be allowed] to chuse his own priest and his own religion as he thought proper’ because this would dilute religious ‘zeal’ and make it ‘altogether innocent when society is divided into two or three hundred, or perhaps into as many thousand small sects, of which no one could be considerable enough to disturb the publick tranquillity” (p 793; p 745).

This was his main concern; to allow freedom of religious belief as an antidote to the excesses of the Established Churches when interfering in the daily lives of people.

To this wish, he added two more: education in science, because science was the ‘great antidote to the poison of enthusiasm and superstition’, and ‘the frequency and gaiety of public diversions”:

“The state, by encouraging, that is by giving entire liberty to all those who for their own interest would attempt without scandal or indecency, to amuse and divert the people by painting, poetry, music, dancing; by all sorts of dramatic representations and exhibitions, would easily dissipate, in the greater part of them, that melancholy and gloomy humour which is almost always the nurse of popular superstition and enthusiasm. Public diversions have always been the objects of dread and hatred to all the fanatical promoters of those popular frenzies. The gaiety and good humour which those diversions inspire were altogether inconsistent with that temper of mind which was fittest for their purpose, or which they could best work upon. Dramatic representations, besides, frequently exposing their artifices to public ridicule, and sometimes even to public execration, were upon that account, more than all other diversions, the objects of their peculiar abhorrence.” (WN V.i.g: p 796; Canaan, 1937 ed. p 748)

I recommend readers to cast their minds over what is probably the most neglected chapter in Wealth Of Nations and which deals with what he considered to be an obstacle to the spread of opulence among all the members of a society, and, as it stood in Britain, a cause of much needless unhappiness (how many economists writing on measuring ‘happiness’ today have read it, I wonder?).

Catherine Rampell would certainly benefit from understanding why Adam Smith advocated widespread religious tolerance, manifested in a society allowing all forms of religion to compete for the attention of potential adherents, and for open competition among the numerous sects was one element of his policy of avoiding a dominant religion emerging to gain political power and influence.

That was, after all, the brilliant insight of the Founding Fathers in their legislative separation of religion from the State in the US constitution.

An Imaginary Perspective of History

Niall Ferguson, a contributing editor of the Financial Times and the author of ‘The Ascent of Money: A Financial History of the World’ (Penguin), writes in FT.com, 27 December, HERE:

“An imaginary retrospective of 2009”

“As Adam Smith had foreseen in The Wealth of Nations, economic liberalisation had allowed the division of labour and comparative advantage to operate on a global scale.”

CommentEr, not quite. Long before Adam Smith (genius that he was) put pen to paper, global markets operated across Europe, and from the geographical explorations of the New World, began to link up with distant lands, in their case by systematic plunder by Spain in Central America and in India and south-east Asia (Dutch, Portugal, England (Britain) and France.

Adam Smith’s account of the global links in the manufacture of the common labourer’s woolen coat (Wealth Of Nations, Book I, chapter 1) is a description of what was happening already, before a version of ‘economic liberalisation’ came into practice.

Indeed, long before anybody wrote about free economies and a large-scale roll back of legislative interventions in economic life, there was a brisk, sustained, and expanding trade between and within European countries from the 14th century, which contributed the international division of labour.

Adam Smith, as a philosopher, was an observer, not an initiator.

‘Overselling’ his role is persistent, though a relatively minor transgression on his reputation.

Of far greater importance are the daily distortions of his radical assessment of how economies work and how they may be better able to work if people, not just legislators and those who influence them, would also first observe and not then offer prescriptions to ‘improve’ what happens anyway, often without the slightest contact with what is happening now and what brought to pass the ‘fine mess we are often in’.

Friday, December 26, 2008

Legislators and Outcomes Are Not as Intended

Steve Gilbert posted on the Sweetness and Light Blog (26 December), "What Has Been Obama’s Plan All Along?"HERE:

“It should come as no surprise, then, that we have a tendency to take our free-market system as a given, to assume that it flows naturally from the laws of supply and demand and Adam Smith’s invisible hand. And from this assumption, it’s not much of a leap to assume that any government intrusion into the magical workings of the market— whether through taxation, regulation, lawsuits, tariffs, labor protections, or spending on entitlements—necessarily undermines private enterprise and inhibits economic growth. The bankruptcy of communism and socialism as alternative means of economic organization has only reinforced this assumption. In our standard economics textbooks and in our modern political debates, laissez-faire is the default rule; anyone who would challenge it swims against the prevailing tide.

It’s useful to remind ourselves, then, that our free-market system is the result neither of natural law nor of divine providence. Rather, it emerged through a painful process of trial and error, a series of difficult choices between efficiency and fairness, stability and change. And although the benefits of our free-market system have mostly derived from the individual efforts of generations of men and women pursuing their own vision of happiness, in each and every period of great economic upheaval and transition we’ve depended on government action to open up opportunity, encourage competition, and make the market work better.”

CommentI pass over the subject of the post about Obama; it is not relevant to my comments on the above two extracted paragraphs and I do not comment onm politcs in other countries.

The political economy summed in the extracts is only the media’s version of Adam Smith, who never linked his chapters on supply and “effectual demand” to anything to do with the metaphor of “an invisible hand” (only mentioned once throughout Wealth Of Nations). Nor was Adam Smith linked to ‘laissez-faire’ in his lifetime; he never used the words and, if anything, considered those who used them, such as the French Physiocrats in the 1760s, were too extreme in their ambitions for commercial economies.

Adam Smith never flinched from swimming “against the prevailing tide” (neither does Lost Legacy on these matters.) Hence , I am pleased that the first sentence of paragraph two, “It’s useful to remind ourselves, then, that our free-market system is the result neither of natural law nor of divine providence”, is so clear and unequivocal.

Why? Because the advocates of myths about Adam Smith and laissez-faire and invisible hands, quite often go on the link him to “the magical workings of the market”, a wholly superstitious assertion.

Markets did emerge “through a painful process of trial and error” but not via “a series of difficult choices between efficiency and fairness, stability and change”.

True, individuals may have made choices, but wholly without any ‘system’ of ‘equity, fairness, stability, and change’ in mind. All those sorts of assertions are a post-event reconstruction by ideologues.

As is the idea that “government action” opened up “opportunity”, encouraged “competition”, and made “the market work better”, which is so contrary to historical fact as to be breathtaking.

Elizabethan governments certainly intervened with 'good' intentions – to increase the pace of commercial changes in 16th century – but in almost (I may have missed some) every case the result of their legislative interventions (The Statute of Apprenticeships – for ‘quality’; the town Guilds – to ensure regular supplies of produce to consumers; and the Settlement Acts – to curb local burdens from beggars and ‘welfare’ scroungers) was the opposite and unexpected because they removed competition and didn’t increase it; the Guilds restricted competition and raised monopoly prices; and instead of settling people these laws prevented it.

Legislative intentions are processed by people and people have interests that can and do work against the intentions of the legislators, giving the legislators the benefit of the doubt for the sake of the argument (I reserve judgment on the intentions of those who influence them).

Richard Epstein Reports Accurately the Kirkcaldy Adam Smith

“Richard Epstein of the University of Chicago talks with EconTalk host Russ Roberts about the relationship between happiness and wealth, the effects of inequality on happiness, and the economics of envy and altruism. He also applies the theory of evolution to explain some of the findings of the happiness literature.”

“People think Adam Smith was a proponent of getting whatever you can and get ahead; but that was not his view; Theory of Moral Sentiments. Word “sentiment”–what he meant was the effort to figure out how people react toward the misfortunes of others. You don’t treat them as acutely as if they are your own; but you are not completely indifferent either. Impossible to only care about your children but not your children’s friends. Theory of inclusive fitness.”

CommentGreat to see positive reports of Adam Smith’s thinking because it makes a change (for the better). Would that the habit would spread!

So much is reported that carries ‘lies, damned lies, and as good as lies, otherwise known as quotations torn from their context’.

A Pensioner Defies the Tide

Robert Sheer, a company-pensioned retiree from the Los Angeles Times, writes: “Republicans bring Socialism to America” on the ‘Fold/Spindle/Mutilate 2.1' Blog HERE:

“It’s enough to drive one back to the invisible hand of Adam Smith. Personally, I would rather we took our chances these days with letting the corporations sink or swim on their own without government interference. If tough love was good enough for troubled families cut off the public dole by Clinton’s welfare reform, which summarily ended the federal poverty program, why have a poverty program for troubled corporations?”

CommentBig Government is always accompanied by big business. The complex connections between legislators and those who influence them (and those many others who attempt to influence them) makes for a large non-separated, non-independent, and largely dependent capitalism, well short of the ‘ideal’ of laissez-faire, as imagined by exponents of ‘free- enterprise America’, of which Robert Sheer would appear to be an advocate.

Ironic, that the only use by Adam Smith of the metaphor of an invisible hand in all of Wealth Of Nations was in relation to the risk avoidance of some, but not all, merchants who preferred to use their capital locally rather than risk it in profitable ventures abroad (that is in the British colonies in North America) and in so doing they automatically (by the arithmetical ‘law’ that the whole is the sum of its parts) made more capital available for increasing local employment and profit-making enterprises in Britain than would it otherwise would have experienced.

And even then, not to put too fine a point on it, the British state was intimately connected to both sets of merchants – those who traded with the North American colonies and those who stayed at home – through the Navigation Acts (since Cromwell’s time, when Britain was menaced by Dutch naval power), which enforced a total monopoly on sea trade for British-owned and British-crewed shipping; through various monopoly laws forcing colonists to send their exports only to Britain first (some of which was then re-shipped in local shipping to the continent) and, forsooth, forced them only to import British products for re-sale and use in the colonies. All this backed by the military presence of British troops and naval vessels, and British laws, at no small expense (the 7-years war alone cost £120 million). The rebellion of the colonists swapped one interfering government for another one (albeit a much improved version; the US Constitution is a monument to civilisation).

As governments got bigger, the intimate connection of monopolists, protectionists with government, and the application of multiple laws and legal processes, spending grew in step. And so it has in the USA, of which Robert Sheer now calls on government not to ‘bail out’ large sections of the US economy in pursuit of a nirvana under the slogan of taking ‘our own chances’. What bravery! What sacrifice of personal chances in pursuit of principle (one, incidentally, that never existed)!

What happens next when Robert Sheer’s pension folds under growing claims for pensions along with collapsing capital assets that are the source of his pension, dry up under ‘tough love’ capitalism? There is a pile of paper entitlements to earnings from real assets, but no locked box of cash lying in some vault somewhere from which Robert’s pension is paid each month!

Frankly, I am in awe at Robert’s defiance. I am also old enough to know that when the proverbial hits the fan he will need the stoicism of a saint not to demand that politicians do something about his new status of poverty, such as by adopting the ‘right’ policies (whatever they are) to get the economy ‘moving’ again.

And I wouldn’t rely on the so-called invisible hand to set it right; the metaphor is not about how markets work, so much as what risk-avoidance drives separate people to do or not do with their scarce assets.

Adam Smith Favoured Publicly Funded Public Works

“What the urban middle classes and the elite want is not democracy but Adam Smith’s night watchman State which does nothing more than the strong and efficient protection of the life, limbs and property of the people (read the classes).”

CommentAs I mentioned yesterday, the phrase the “night watchman State” did not come from Adam Smith – he never used such a phrase; his ideas of the duties of the state went well beyond the ‘first duty’ of security – and, anyway, the phrase itself was not used until the 1850s, and then not by an adherent of Smith’s political economy.

The ‘night watchman state’ was first uttered by Ferdinand Lassalle, a firebrand, leftwing socialist, in his disparagement of bourgeois state intervention, taunting them because they did not advocate taking full advantage of the awesome state power of 19th-century European states to take over much of the commercial activities of their economies.

How then did it become associated with Adam Smith? Well, possibly, via the usual route of assimilation by those who hadn’t read their Adam Smith too closely, if at all, and from their not appreciating what he was talking about in what quick readers of Book V of Wealth Of Nations thought were his ‘modest’ proposals for government.

Defence expenditures (the first duty of the sovereign) were the largest single budget expenditure in the 18th century (the seven years war cost £125 million). It continued to rise until after the Napoleonic Wars (the on-and-off 23years war). Justice (the second duty) was also expensive, especially as the number of possible crimes codified into law rose dramatically in the last quarter of the 18th century (and led to the colonisation of Australia from 1788 for convicts).

But the real potential source of approved growth lay in the third duty, that of expenditures on public works and public institutions that facilitated commerce or were advantageous for social stability.

Roads, harbours, canals, and bridges formed a massive agenda for public expenditure and if carried out diligently would have added tens of millions to public expenditure annually for much of the next 50 years. To which, in time, would have spread expenditurs from what was called ‘police’ to city water, sewage and refuse disposal, and public health (he also suggested palliative care of leprosy victims and other ‘loathsome diseases’ in Wealth Of Nations - glimmers of a public health service?

Of public institutions, the main one was the ‘education of youth’. The public provision of ‘little schools’ in every parish (about 60,000 of them) alone would have been a massive budget line for the buildings and state subsidies of teacher remuneration, supplemented by fees charged to all parents, except the most destitute.

Smith already supported the public funding of the Royal Mint and the Post Office, plus various government inspectorates to ensure quality in certain outputs (bullion assaying; hallmarks; stamping of certain cloths, etc.,), and government officers of customs and excise, tax collectors and civil servants.

‘The dignity of the sovereign’, or the expenses of government, was a separate budget line too, and was bound to grow as governments grew larger across the economy at both national and local levels, as seen in the magnificent 19th century town halls and public buildings erected across the UK.

So, if ‘even Adam Smith’ had a large, and potentially growing, public expenditure agenda, it was consistent with his central theme that these expenditures were to ‘facilitate commerce’, and not to manage it or ‘crowd it out’, or replace it.

If anything, Smith’s admonition to his readers was to facilitate commercial markets where possible (clearly, in time, capital would become, and became, available for privately-financed, infra-structure projects), and also to utilize publicly-funded activities where necessary.

As always, Adam Smith was not an ideologue.

Postscript: a merry Christmas to all readers who catch this post today; and season's greetings to everybody else later.

Meanwhile, I have nine more exam scripts to grade ... before the usual family dinner.

Wednesday, December 24, 2008

Intellectual Life Does not Influence Everyday Life That Much

Canadian Content Blog carries an article, “The evangelical roots of economics” from “Let there be markets: The evangelical roots of economics”, extracted from Gordon Bigelow’s piece in Harper's Magazine (HERE):

“When evangelical Christianity first grew into a powerful movement, between 1800 and 1850, studies of wealth and trade were called “political economy.” The two books at the center of this new learning were Adam Smith’s Wealth of Nations (1776) and David Ricardo’s Principles of Political Economy and Taxation (1817):

"This was the period of the industrial transformation of Britain, a time of rapid urban growth and rapidly fluctuating markets. These books offered explanations of how societies become wealthy and how they can stay that way. They made the accelerated pace of urban life and industrial workshops seem understandable as part of a program that modern history would follow. But by the 1820s, a number of Smith’s and Ricardo’s ideas had become difficult for the growing merchant and investor class to accept.

For Smith, the pursuit of wealth was a grotesque personal error, a misunderstanding of human happiness. In his first book, The Theory of Moral Sentiments (1759), Smith argued that the acquisition of money brings no good in itself; it seems attractive only because of the mistaken belief that fine possessions draw the admiration of others.

Smith welcomed acquisitiveness only because he concluded—in a proposition carried through to Wealth of Nations—that this pursuit of “baubles and trinkets” would ultimately enrich society as a whole. As the wealthy bought gold pickle forks and paid servants to herd their pet peacocks, the servants and the goldsmiths would benefit. It was on this dubious foundation that Smith built his case for freedom of trade.

By the 1820s and ’30s, this foundation had become increasingly troubling to free-trade advocates, who sought, in their study of political economy, not just an explanation of rapid change but a moral justification for their own wealth and for the outlandish sufferings endured by the new industrial poor. Smith, who scoffed at personal riches, offered no comfort here. In The Wealth of Nations, the shrewd man of business was not a hero but a hapless bystander.

CommentThis type of article which links books written in 1759 (Moral Sentiments) and 1776 (Wealth Of Nations) by Adam Smith with another by David Ricardo in 1817 (Principles of Political Economy and Taxation) with the collective views of a “growing merchant and investor class to accept”, only become acceptable by distance of the reader from the relevant events.

While many ‘merchants and investors’ were educated at the time (and many others weren’t) it is a bit of a stretch to accepts that they were familiar with Smith’s and Ricardo’s texts (the last author is especially suspicious of people such as busy ‘merchants and investors’ being familiar with his work – a most obscure text if ever there was one!).

I suspect that the influence of intellectuals is much less than commentators might think, perhaps in the belief that because we read these works still, it must have been the case that they were widely read by entrepreneurs too. It is more likely that if none of the above books were written, that events in markets, development, innovation and growth would have continued in much the way that they did anyway. There is an intellectual life and an everyday life; the latter may influence the former but the former is less likely to influence the latter.

The chattering classes who ‘translate’ notable texts, and who make notable text more familiar to the each other and to those who listen to them, also filter ideas in the process of their popularising versions of them, quite often at the expense of vulgarising their authors’ ideas, where they don’t suppress things they choose to ignore. Hence, Adam Smith’s holistic ideas were filtered down to a few words, such as ‘laissez-faire’ (which happened not to be his ideas at all – he never mentioned these words once), or ‘night watchman state' (spoken not by Smith but by the socialist firebrand, Ferdinand Lassalle, who actually mocked the idea of a smaller, leaner bourgeois state).

A century later, in fact, a further filtering took place around the metaphor of ‘an invisible hand’. In all these cases, the extent of the knowledge of many people who have heard the name ‘Adam Smith’, but never read his books, is limited to these three erroneous propositions alleged to be his, ‘laissez-faire', ‘night-watchman state', and ‘invisible hand’.

The idea that the “growing merchant and investor class” gave a moment’s thought to either Adam Smith or David Ricardo, frankly, is quite ludicrous. That the educated classes of religious orthodoxy and evangelical enthusiasm concocted a ‘plausible’ narrative as described by Gordon Bigelow is perfectly possible. That it had anything to do with Adam Smith’s ideas is quite irrelevant, as anybody turning the pages of either of his books would grasp in no time.

Incidentally, per capita incomes rose throughout the 19th century, despite the dreadful conditions of those urban labourers at the very bottom of the social heap and they continued to do so throughout the 20th century. If the urban poor were near destitute, the lot of the rural poor was even worse, as it is today for the same division of populations in the poorer countries of the world.

Adam Smith Favoured Publicly Funded Public Works

“Given that infrastructure in Canada is generally agreed to be in bad need of some work, given the economic value infrastructure has, and given that even Adam Smith was in favour of certain kinds of infrastructure spending, this is a hell of a lot better than spending money on John Turner-style make work programs or government day cares or whatever.”

CommentI was struck by the unnecessary word ‘even’ in front to Adam Smith: “even Adam Smith was in favour of certain kinds of infrastructure spending”.

Presumably ‘Kerplonka’ has little familiarity with the Adam Smith (born in Kirkcaldy in 1723) who was author of Wealth Of Nations (1776; Book V, to be exact).

Maybe he is more familiar with the ‘Adam Smith’ invented in Chicago in the 1950s, who is credited with all kinds of ideas he never held.

The Kirkcaldy Adam Smith, on the other hand, was very much in favour of public works and public institutions that facilitated commerce, which he considered should be funded by government in their construction, and that their management and maintenance should be funded by some combination of public and private monies, including by charges for those who used the facilities (with the rich paying more where practicable).

It is pleasing to see that the Kirkcaldy Adam Smith is coming to the attention of the good people of Canada. I hope their interest in the genuine article will continue.

An Evolutionist Speaks Out About Economists' Pretensions About Science

Massimo Pigliucci, professor in the departments of Ecology and Evolution, Stony Brook, NY, contributes an important piece of work in the Blog,Rationallyspeakingout.org (‘a site devoted to positive scepticism') (HERE):

“Economics learns a thing or two from evolutionary biology”

“Economics is supposed to be a solid discipline, founded on complex mathematical models (and we all know math is really, really difficult). They even give Nobel prizes to economists, for crying out loud! And yet, economics has always had to fight off the same reputation of being a “soft” science that has plagued sociology, psychology, and to some extent even some of the biological sciences, like ecology and evolutionary biology. Indeed, like practitioners in those other fields of inquiry, some economists admit of being guilty of “physics envy,” that is, of using the physical sciences as the model for what their field ought to be like. Turns out even the assumption that a good science should be modeled on physics is “flawed,” to use Greenspan’s apt phrase.

“A recent article by Chelsea Wald in Science (12 December 2008) puts things in perspective by asking how it is possible that so many smart people in the financial sector made irrational decisions over a period of years, despite clear data showing there was a problem, and eventually leading to a worldwide economic crisis that is at the least poking at, if not shaking, the foundations of capitalism itself.

Part of the answer is to be found in the persistent idea in economics that “markets” work because people are rational agents who act in their own self-interest and have perfect, instantaneous access to relevant information about the businesses they are considering investing in. Economists are not stupid, and they know very well that perfect rationality, complete information and instant access are all light years away from the reality of how markets operate. And in fact recent models have relaxed these assumptions to some extent. But it is so much more tractable to model things that way! After all, physicists do it too: remember those problems in Physics 101 that started “consider a spherical cow…”?

“Perhaps not surprisingly, there is another science that has been inspiring economists for some time now: evolutionary biology. The old “efficient markets hypothesis” underlying classical models is being replaced by the “adaptive markets hypothesis,” where Adam Smith’s invisible hand becomes more directly analogous to natural selection.”

”As evolutionary biologists have found out, natural selection is not an optimizing process, but a satisficing one, meaning that it produces whatever outcome happened to be achievable at a particular historical moment and that works “well enough” for the problem at hand. Moreover, it does so while “wasting” a lot of resources and often marching straight into dead ends (just think that over 99% of the species that ever existed went extinct). The emerging picture is much more realistic than the rationalist paradigm, but it sure is a lot more messy too.”

“There is another lesson to be learned from evolutionary biology that will not make economists, or the public at large, particularly happy: when complex systems evolve over time the paths they take is contingent on historical accidents (as opposed to being deterministic, like the laws of macro-physics, outside quantum mechanics). Sociologists, psychologists, ecologists and evolutionary biologists will readily tell their economic colleagues that it is certainly possible to explain past events (the extinction of the dinosaurs, the dot-com bubble) by the use of sufficiently complex causal-historical models. What seems to be out of reach, however, is precisely what economists want most: predicting the future, the hallmark of “good” science.”

“The moral of the story is that all of the above is not a failure of economics, sociology, psychology, ecology or evolutionary biology. It is the predictable outcome of the fact that these sciences deal with complex, historical systems, unlike much (though not all) of physics. The real assumption we need to get rid of is the highly persistent and pernicious one that physics is the golden standard by which all other sciences ought to be measured. Now if we only could convince federal funding agencies of that...”

CommentWhat a breath of fresh air from Professor Massimo Pigliucci! I wish (more in hope than expectation) that fellow economists will read all of his article. But because there are large dollops of research-grant money – and even bigger salaries from financial institutions (and government agencies) – available to smart-talking economists, who tell the grant agencies exactly what they want to hear, there is a steady demand for the services of 'future predictors' and no amount of their constant failures to do better than tossing a ten-pence coin could do, will curb the willingness to believe those in the prediction business.

It’s at least as bad as the historians of the immediate past, when they already know what has happened, who cannot agree on what caused, led to, or contributed to whatever is the latest ‘fine mess’ we’re in.

The historical precedents for this quite silly state of affairs goes back to classical times, and almost certainly farther back than that. Romans believed in ‘omens’ and fortune tellers, and even great generals, who pitted their lives against formidable foes, eagerly listened to what soothsayers and mystics had to say about the next few hours in decisive battles.

Among economists, we have bought the unscientific myth that if we spend a century creating beautiful mathematical models of an imaginary economy, without people in all their complexity and unpredictability, and our competence is judged by our understanding of the model, but not the reality of real economies!

We are a ‘hard’ science and much ‘superior’ to ‘wishy-washy sociology, psychology and history, even though it is well-known that humans are not ‘well behaved’ like physical objects. We are not like wooden pieces on a chess board, as Adam Smith put it.

It is worrying too that just as more economists begin to realise that “the old 'efficient markets hypothesis' underlying classical models is being replaced by the 'adaptive markets hypothesis,' into which realisation, the oldest nonsense in modern economics (invented as a mass myth from the 1950s), is being re-introduced into the latter, under the guise that the metaphor of “Adam Smith’s invisible hand”, such that it is to be regarded as “more directly analogous to natural selection.”

Please spare us from this spurious nonsense; it’s bad enough that the proponents of the so-called scientific basis of economics have got away with their claims that the mystical disembodied body part was the ‘most important idea’ of modern economics, which is something that they never got from the texts of Adam Smith (see my paper: 'Adam Smith and the Invisible Hand: from metaphor to myth’, 2008 and downloadable from the homer page of Lost Legacy).

The myth of the invisible hand is a fabrication to support propaganda for corporate bodies to behave with all the monopolistic spirits and protectionism of the ‘merchants and manufacturers’ of his day, against whom Adam Smith railed in Wealth Of Nations because they persuaded legislators and those who influenced them (and they ‘bought’ not a few) to assist them in narrowing the competition and raising prices.

Tuesday, December 23, 2008

Foucault on Economics

“Very often economics is taught (in India) as if the present day economics is what has evolved out of the previous economic theories. Therefore, the multiple paradigms that prevail in economics are seldom expressed clearly. It is not uncommon to learn the theories of Adam Smith, David Ricardo, Thomas Malthus, etc under Classical theories. Then, they are forgotten. They are mentioned as the initial thinkers. No more are they mentioned nor their relevance. For, neo-Smithians, neo-Rocardians, neo-Malthusians, etc are very much present. And, they do come out with better theories than the neoclassical economists.

This post suggests that one ought to know that there are ‘other’ truths (heterodox economic theories) apart from the truth that we are taught – neoclassical economics. And in this aspect, a reading of Foucault will prove to be immensely insightful.”

CommentMy advice to an undergraduate economist, especially someone who realises that their syllabi raises more questions than it answers, is to pursue their doubts, but to continue their studies diligently too, always.

There is much doubtful about neo-classical economics, as I sometimes allude to on Lost Legacy, but for purposes of earning the right to say so, and to research and teach alternative ideas, such as are found in Adam Smith and others, it is necessary to pass the examinations that are set by adherents of the current orthodoxy, and competence in neo-classical economics is the required standard by which academic posts are filled.

By all means read beyond the official reading list (Foucault included, though, personally, I would place Adam Smith’sLectures on Jurisprudence at the top of my list), but you must read the official list too.

Your fellow students, who soak up uncritically the class tutors’ reading lists, believe me, with one or two exceptions, will read just enough to pass their tutors’ exams and will leave many subsidiary titles alone. For you, read all titles on the list, and in the citations and footnotes, in addition to the alternative titles, all more than enough to pass your exams.

And to pass them is the objective for you to go on to follow your doubts and, perhaps, create the alternative approaches, currently in the shadows.